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Wednesday, November 29, 2006

Sometimes the best way to know someone is by observing the company they keep. I believe that is the case with Wachovia Bank. Wachovia(WB) became one of our largest holdings when it bought our favorite bank, Birmingham Al. based Southtrust. We owned Southtrust(SOTR) because we thought it was the best regional Sunbelt bank, which was largely the result of the leadership of chairman, Wallace Malone.
Malone was a straight-talking old fashioned banker who kept his costs low and never missed an opportunity to go where the the gettin' was good. I thought he understood the power of a bank and how to squeeze profits out of it as well as anyone.
When he sold Southtrust to Wachovia, I was shocked. Among the 4 or 5 big banks headquartered in Birmingham, I thought Southtrust would be the last to merge. But not only did he sell out to Wachovia, he sold at a modest premium to the banks market price, and well under what he could have received if he would have sold the bank at auction.
Wallace Malone is nobody's fool and the more I thought about it, the more I became convinced that Malone had concluded that bigger was better and that even though SOTR would not be the surviving bank, he wanted a "southern culture" and a commitment to maintain his cost control and entreprenerial beliefs. In short, Malone was not selling out as much as he was arranging a marriage where SOTR's unique culture would be honored and preserved.
The integration of the two companies went well and, indeed, Wachovia's increased emphasis on cost controls, combined with the strong Sunbelt economy, pushed the company's stock up nearly 30% through early 2006. Then the company announced it was buying another icon Oakland California's Golden West Financial(GDW).
GDW was as unique to the West as SOTR was to the South. It thrived in a very competitive leading market on incredibly nibble and flexible mortgage products and very tight cost controls. Husband and wife co-CEOs Herbert and Marion Sandler built Golden West from $38 million in assets to nearly 130 $billion in assets during their 40 years with the company.
Again when I saw the news that GDW had sold out, I was surprised. The Sandlers were getting older, but they had been so successful and GDW had reached a critical mass where it could have easily remained independent. The market did not like anything about Wachovia's purchase of Golden West. There were few economies of scale, GDW was heavy into California mortgages at a time when it was clear the housing market was softening, and WB appeared to pay a premium for the company. WB's stock fell by nearly 20% in the month after the announcement of the purchase.
WB's price is still under pressure but I think the GDW purchase will ultimately be seen as a brilliant move. GDW is, indeed, very heavy in California real estate, but they have among the most stringent credit controls of all lenders. This has kept their loan loss ratios very low, and the real estate market would have to get a lot worse than I see it getting for them to have any trouble. More importantly, WB has now taken a kind of watermelon rind approach to their geographic footprint. Beginning on the eastern seaboard their market extends to Florida; then continues through the Sunbelt and the Southwest before smiling up through California and the Nortwest. This watermelon rind market area includes most of the fastest growing markets in the United States. I think there will be few large banks that will be able to rival WB's earnings and dividend growth over the next decade.
Finally, and perhaps most importantly, two of the most impressive banking families that this country has produced over the last 40 years have thrown their lots in with Wachovia and now will be among its largest shareholders. In my judgment, neither of these deals was entirely about the money. And that speaks volumes about Wachovia. Mr. Malone and the Sandlers chose WB to act as stewards of everything that they have built. If the Malones and the Sandlers, who built multibillion dollar banks from scratch are confidant in WB's future, I feel like I am in good company in holding the stock.
This blog is for information only. Do not make buy and sell decisions based on the information contained here. Please consult your own financial advisor.